Market Anticipates Potential Rate Cut Amid Favorable Inflation Data

The softer-than-expected inflation report for June has heightened market expectations of a rate cut by the end of the year, possibly before the November elections. This speculation has contributed to the recent decline of the US dollar and a surge in various market sectors, including bonds, small-cap stocks, and homebuilders.

The current inflation data is more favorable for rate cuts than it was at the end of last year. As of December, the three-month annualized consumer price index (CPI) was below the Fed's 2% target after adjustments. Additionally, core CPI, which excludes volatile food and energy prices, fell below the target, registering at 1.8% on a three-month adjusted basis.

If inflation continues to remain low and the Federal Reserve is confident it will stay that way, policy rates are likely to be lowered before the end of 2024, potentially ahead of the elections. Ideally, Fed Chair Jay Powell might prefer not to change rates before an election, but such preferences can be overridden by economic data.

Historical precedent shows the Federal Reserve has altered rates in the months leading up to presidential elections. Since 1974, during the 10 months preceding the 13 presidential elections, the Fed has changed rates eight times and maintained them five times. This history indicates that the central bank does not hesitate to make policy changes during election periods if warranted by economic indicators.

As the market reacts to the latest inflation data and its implications, the Federal Reserve, under Chair Powell's leadership, remains committed to responding to economic data. An interest rate change before the November elections is likely if current inflationary trends persist.